Chapter Six Business- Level Strategy and the Industry Environment

Chapter Six

Business- Level Strategy

and the Industry

Environment

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 2

““All men can see All men can see these tactics whereby these tactics whereby I conquer but what I conquer but what none can see is the none can see is the strategy out of which strategy out of which victory evolves.”victory evolves.”

- Sun Tzu- Sun Tzu

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The Industry Environment

Different industry environments present different opportunities and threats.

A company’s business model and strategies have to change to meet the environment.

Companies must face the challenges of developing and maintaining a competitive strategy in:

• Fragmented Industries • Mature Industries• Embryonic Industries • Declining Industries• Growth Industries

There is the need to continually formulate and implement business-level strategies to sustain competitive advantage over time in different industry environments.


Fragmented Industries

Reasons for fragmented industries• Low barriers to entry due to lack of economies of scale• Low entry barriers permit constant entry by new companies• Specialized customer needs require small job lots of

products - no room for a mass-production• Diseconomies of scale

Strategies• Chaining – networks of linked outlets to

achieve cost leadership• Franchising – for rapid growth with proven business concepts,

reputation, management skills and economies of scale• Horizontal Merger – acquisition to obtain economies and growth• IT and Internet – to develop new business models

A fragmented industry is one composed of a large number of small and medium-sized companies.


An embryonic industry is one that is just beginning to develop when technological innovation creates new market or product opportunities. A growth industry is one in which first- time demand is expanding rapidly as many new customers enter the market.

Embryonic and Growth Industries

Strategy is determined by market demand• Innovators and early adopters have different needs from

the early and late majority• Company must be prepared to cross the chasm between

the early adopters and the later majority

Companies must understand the factors that affect a market’s growth rate – in order to tailor the business

model to the changing industry environment.


Market Characteristics: Embryonic and Growth Industries Reasons for slow growth in market demand

• Limited performance and poor quality of the first products

• Customer unfamiliarity with what the new product can do for them

• Poorly developed distribution channels

• Lack of complementary products

• High production costs

Mass markets typically start to develop when:• Technological progress makes a product easier to use and

increases its value to the average customer.

• Key complementary products are developed that do the same.

• Companies find ways to reduce production costs allowing them to lower prices.


Market Development and Customer Groups

Both innovators and early adopters enter the market while the industry is in its embryonic state.

Figure 6.1


Market Share of Different Customer Segments

Most market demand and industry profits arise during the early and late majority customer segments.

Figure 6.2


Strategic Implications: Crossing the Chasm

Innovators and Early Adopters are (While the Early Majority are NOT):• Technologically sophisticated and tolerant of engineering

imperfections• Typically reached through specialized distribution channels• Relatively few in number and not particularly price-sensitive

To cross the chasm between the Early Adopters and the Early Majority • Correctly identify the needs of the first wave of

early majority users.• Alter the business model in response.• Alter the value chain and distribution channels to

reach the early majority.• Design the product to meet the needs of the early majority so that

the product can be modified and produced or provided at low cost.

• Anticipate the moves of competitors.


The Chasm: AOL and Prodigy

The business model and strategies required to compete in an embryonic market populated by Early Adopters and

Innovators are very different than those required to compete in a high-growth mass market populated by the Early Majority.

Figure 6.3


Strategic Implications of Market Growth Rates

Different markets develop at different rates. Growth rate measures the rate at which the

industry’s product spreads in the marketplace. Growth rates for new kinds of products seem to

have accelerated over time:• Use of mass media • Low-cost mass production

Factors affecting market growth rates:• Relative advantage • Complexity• Compatibility • Observability• Availability of • Trialability

complementary products

Business-level strategy is a major determinant of industry profitability. The choice of business model and strategies can accelerate or retard market growth.


Differences in Diffusion Rates

Source: Peter Brimelow, “The Silent Boom,” Forbes, July 7, 1997, pp. 170-171. Reprinted by permission of Forbes Magazine © 2002 Forbes, Inc.

Different markets develop at different growth rates.

Figure 6.4


Navigating Through the Life Cycle to Maturity

Embryonic stages – share building strategies • Development of distinctive competencies and competitive advantage.• Requires capital to develop R&D and sales/service competencies.

Growth stages – maintain relative competitive position• Strengthen business model to prepare to survive industry shakeout.• Requires investment to keep up with rapid growth of the market.

Shakeout stage – increase share during fierce competition• Invest in share-increasing strategies at expense of weak competitors.• Weak companies should exit the industry during the harvest stage.

Maturity stage – hold-and-maintain to defend business model• Dominant companies want to reap the reward of prior investments.• A company’s investment depends on the level of competition and

source of the company’s competitive advantage.

1. Competitive advantage of company’s business model2. Stage of the industry life cycle

The amount and type of resources and capital needed to pursue a company’s business model depends on two crucial factors:


Mature Industries

Evolution of mature industries• Industry becomes consolidated as a result of the fierce

competition during the shakeout stage. • Business level strategy is based on how established companies

collectively try to reduce strength of competition.• Interdependent companies try to protect industry profitability.

Strategies• Deter entry into industry

Product proliferation Maintaining Price cutting excess capacity

• Manage industry rivalry Price signaling Capacity control Price leadership Nonprice competition

A mature industry is dominated by a small number of large companies whose actions are so highly interdependent that success of one company’s strategy depends on the response of its rivals.


Strategies for Deterring Entry of Rivals

Filling the Niches: making it difficult for new

competitors to break into a new industry & establish a

beachhead

Sending a Signal: to potential new entrants

contemplating entry that new entry will be met with

price cuts

Warning of Retaliation: by increasing output and forcing down prices until market entry would be unprofitable to entrants

Figure 6.5


Product Proliferation in the Restaurant Industry

Where the product spaces have been

filled, it is difficult for a new company to

gain a foothold in the market and

differentiate itself.

Figure 6.6


- Ray Kroc, Founder of McDonalds

“We built our company by focusing upon a pretty simple, but focused premise of Quality, Service, Cleanliness, and Value.”

www.mcdonalds.com


Strategies for Managing Industry Rivalry

Convey intentions (e.g. Tit-for-Tat)

regarding pricing to other companies to allow the industry to choose the most

favorable pricing options.

Intent is to improve industry profitability.

Informal pricing when one

company takes the responsibility for

choosing the most favorable industry

pricing option.

Formal price setting jointly by companies

is illegal.

Differentiation by offering products with different features or

applying different marketing techniques: • Market development• Market penetration• Product development• Product proliferation

Market Signaling to secure

coordination with rivals as a capacity control strategy and to reduce industry

investment risks.

Collusion on timing of new investments

is illegal.

Figure 6.7


Four Nonprice Competitive Strategies

Figure 6.8


Toyota’s Product Lineup

Toyota has used market development to become a broad differentiator and has developed a vehicle for almost every main segment of the car market.

Figure 6.9


Game Theory

Basic principles that underlie game theory: Look Forward and Reason Back – Decision Trees

Look forward, think ahead, and anticipate how rivals will respond to whatever strategic moves they make

Reason backwards to determine which strategic moves to pursue today based on how rivals will respond to future strategic moves

Know Thy Rival – how is the rival likely to act Find the Dominant Strategy – Payoff Matrix

One that makes you better off if you play that strategy No matter what strategy your opponent uses

Strategy Shapes the Payoff Structure of the Game

Companies in an industry can be viewed as players that are all simultaneously making choices about which business models and strategies to pursue in order to maximize their profitability.

These basic principles of game theory can be used in determining which business model and strategies to pursue.


A Decision Tree for UPS’s Pricing Strategy

Figure 6.10


A Payoff Matrix for GM and Ford

Figure 6.11


Altered Payoff Matrix for GM and Ford

Figure 6.12


Declining Industries

Reasons for and severity of the decline• Reasons - technological change, social trends, demographic shifts• Intensity of competition is greater when:

The decline is rapid versus slow and gradual. The industry has high fixed costs. The exit barriers are high. The product is perceived as a commodity.

• Not all industry segments typically decline at the same rate Creating pockets of demand

Strategies• Leadership – seeks to become dominant player in declining industry• Niche – focuses on pockets of demand that are declining more slowly• Harvest – optimizes cash flow• Divestment – sells business to others

A declining industry is one in which market demand has leveled off or is falling and the size of total market starts to shrink. Competition tends to intensify and industry profits tend to fall.


Factors for Intensity of Competition in Declining Industries

Figure 6.13


Strategy Selection in a Declining Industry

Choice of strategy is determined by:• Severity of the industry decline• Company strength relative to the remaining pockets of demand

Figure 6.14


““Whatever you shoot is dead for Whatever you shoot is dead for a while before it starts to stink.a while before it starts to stink.

The same goes for strategies.”The same goes for strategies.”

- Gary Hamel- Gary Hamel

© RoyaltyFree/ Lawrence M. Sawyer/ Getty Images

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Chapter Six Business- Level Strategy and the Industry Environment